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Back in 2005 when the new bankruptcy laws were passed by Congress many worried that the laws would have consequences no one imagined. And surprise to surprise, the new bankruptcy law is contributing to the rise in foreclosures across the country.

Everyone thinks of bankruptcy as a tool to get out of debt, but the real reason for bankruptcy is to allow entreprenuers to take on more risk. One of the great things about the American economy is that innovation is very highly valued. And that failure is not punished like in the rest of the world. This has given the United States a competitive advantage that is  disappearing when we fail to reward risk taking.

But today’s growing problem in the housing market is different—foreclosures are soaring, while bankruptcies, though clearly on the upswing, are running roughly at half the 2001-2003 pace. The reason: A new bankruptcy law, approved by Congress in 2005 after years of debate, makes it much harder for households to get out from under their consumer debt. The result: More people being forced to walk away from their homes, leaving lenders holding the bag. Perversely, a law intended to help the financial industry may be damaging the housing sector, creditors and borrowers alike. “It doesn’t matter what you think of the purpose of the new bankruptcy law. The timing is bad,” says Susan M. Wachter, professor of real estate at the Wharton School of Business. via BusinessWeek

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